Don't Blame the Unit of Account
On Jan. 1, the fifth anniversary of the introduction of euro notes and coins, Slovenia became the currency club's 13th member. Recent opinion polls, though, show that a majority of citizens in the larger euro-zone countries don't feel like celebrating. They believe the euro has damaged their national economies, and more than half want their former national currency back. And there is still a perception that the euro has led to price rises even though inflation is below 2%.
In reality, the euro is finally delivering on its promises and is playing a positive role in the current European recovery. Business cycles are more synchronized, and growth and inflation ranges across euro countries are roughly consistent with those across the U.S. According to the OECD, the common currency has increased euro-area trade by 5%-15%. Cross-border mergers and acquisitions are on the rise. For the second year in a row, euro debt surpassed dollar-denominated issues as borrowers world-wide raised capital in euros at an unprecedented pace. Some Asian and Mideastern governments are diversifying their assets out of dollars and into euros, adding to this trend.
If the euro hasn't yet fulfilled all its promises, it's not the currency's fault. The euro eliminates exchange-rate risks, enhances price transparency and provides a more stable environment for trade and investment. Intra-euro area foreign direct investment (FDI) rose to 24% of euro-zone GDP in 2004 from nearly 14% in 1999. Almost one-third of global FDI goes to the euro area, generating jobs, trade and growth. The problem is that uneven progress on domestic reforms and the single market leads to uneven euro benefits, holding back Europe's growth potential.
The euro-zone economy is estimated to have expanded by about 2.6% in 2006. That's better than in previous years but modest by OECD standards. And this year euro-zone growth is estimated to fall to 2.2%. Despite the ability to compare prices across the euro area and an increase in trade within the currency zone, a bias for domestically produced goods still persists. Trade in services remains particularly low. The expected investment boom resulting from economies of scale and lower capital costs that would come with a truly integrated financial market has not materialized yet. That's because a truly integrated financial market has not yet materialized either.
This mixed performance has led some to blame the euro for their economic woes. In summer 2005, former Italian welfare minister Roberto Maroni went so far as to urge a temporary reintroduction of the lira, as if pre-euro Italy were an economic success story.
Nobel Prize economist Robert Mundell first explored the trade-offs that come with joining a currency union. The most significant change is that policy makers lose exchange and interest rates as economic tools. In a currency union, it is the mobility of goods, services and people that provide the answer to asymmetric shocks, which affect some geographic areas of an economy more than others. European economic integration and domestic reforms can provide this mobility. Implementing the directive on Markets in Financial Instruments this coming November will help to forge an EU-wide capital market. But the EU Services Directive fell short of opening up the rest of Europe's service industry. A more ambitious services liberalization, as well as structural reforms in labor, product and financial markets, would widen the single currency's benefits by magnifying competition, mobility and growth.
Upon Slovenia's adoption of the euro, Joaquín Almunia, the EU commissioner for economic and monetary policy, said greater wage flexibility and higher labor productivity growth will be critical to enhancing Slovenia's competitive position and adjusting to asymmetric shocks. This is good advice for euro newcomers and veterans alike.
Mr. White is program officer at the German Marshall Fund of the United States.